Volatility is a term referring to the statistical measure of the dispersion of returns for a security or market index. Most of the time, the higher the volatility is, the riskier the security will inevitably be. Volatility is measurable by using either the standard divergence or deviation between returns from that same security or market index.
In the securities markets, volatility has an association with big swings in either direction. For instance, whenever the stock market rises and falls more than one percent over a period of time, it is a “volatile” market.
When you couple volatility with arguably the longest bear market in the cryptocurrency industry, many investors consider staking as a safer method. Crypto investment firm Pantera Capital partner, Paul Veradittakit, made the following comment about staking’s growing popularity:
“…the ability to stake your tokens and earn interest from staking is a great way to make money, an ability to make strong consistent returns.”
Staking shares some similarities with the act of earning dividends or interest on your investment. With that in mind, it is not a new concept. In a long bear market, though, it’s becoming more rampant among cryptocurrency investors. This is primarily due to possible gains from regular trading not being as fruitful. Kyle Samani, a managing partner at Multicoin Capital Management, states that:
“Regardless of market conditions, staking provides returns denominated in the asset being staked. If you’re going to be long, you might as well stake.”
This article will go deeper into what staking is and what the concept of coin staking pertains to.
Proof of Stake
‘Staking’ is the byproduct of a pre-existing consensus algorithm called ‘Proof of Stake’ (PoS). This is a concept stating that a person can mine or validate block transactions according to their total coin amount. Basically, the more bitcoins or altcoins in a miner’s possession, the more mining power they have.
The purpose of PoS’s creation was to function as an alternative to the ‘Proof of Work’ (PoW) algorithm. To be more specific, it is meant to tackle the basic issues of PoW. This concept describes a system that requires a feasible amount of effort to deter malicious uses of computing power. This includes sending out spam emails or launching denial of service attacks.
To learn more about these attacks (as well as ‘Distributed Denial of Service attacks’), read “What is a DDoS attack?”
Proof of Work
The concept came from Hal Finney in 2004, deriving from the idea of “reusable proof of work.” Following its 2009 introduction, Bitcoin became the first to widely adopt Finney’s idea (in fact, Finney was also the first Bitcoin transaction recipient). PoW assembles the groundwork of many other cryptocurrencies as well.
PoW makes altering any aspect of the blockchain very tricky, seeing as how this alteration requires re-mining all subsequent blocks. Additionally, it makes it difficult for a user or a pool of users to take over the network’s computing power. This is because the machinery and power it needs to properly complete the hash functions are very expensive.
The problem with Proof of Work
PoS’s existence stems from a need to fix the problems with PoW. With a transaction initiation, the data is put into a block with a maximum capacity of 1 megabyte. It also goes through a duplication process across multiple computers or nodes existing on the network. The nodes are essentially the administrative body of the blockchain and they’re responsible for transaction legitimacy validation.
To carry out this step, the nodes or miners have to solve a computational puzzle, which is the ‘PoW problem.’ The first to decrypt each problem will receive coins as a reward. As soon as a block transaction garners verification, it goes to the blockchain.
So, what’s the issue? Well, mining requires a great amount of computing power to run different cryptographic calculations. Moreover, it needs this power in order to unlock the computational challenges. The computing power converts into a high amount of electricity and power that a PoW needs. Investopedia editor, Jake Frankenfield, says that:
“In 2015, it was estimated that one Bitcoin transaction required the amount of electricity needed to power up 1.57 American households per day. To foot the electricity bill, miners would usually sell their awarded coins for fiat money, which would lead to a downward movement in the price of the cryptocurrency.”
The PoS solution
This is where PoS comes in. This is the issue that this algorithm seeks to address. It aims to do this by crediting mining power to the proportion of coins that a miner possesses. So, instead of applying energy to answer PoW puzzles, a PoS miner mines a percentage of the transactions. Specifically, transactions that are reflective of their ownership stake. For example, a miner who owns 3% of the accessible bitcoin can theoretically mine only 3% of the blocks.
Bitcoin utilizes a PoW system and thus, it’s susceptible to a potential Tragedy of Commons. This refers to a future point when there will be fewer bitcoin miners available. This is because there is little to no block reward from mining. The only fees will derive from transaction fees, which will diminish over time as users choose to pay lower fees. With a fewer number of miners mining for coins, the network becomes more vulnerable to a 51% attack.
Frankenfield explains what this type of attack is:
“A 51% attack is when a miner or mining pool controls 51% of the computational power of the network and creates fraudulent blocks of transactions for himself, while invalidating the transactions of others in the network.”
Furthermore, the attacking miner can reverse transactions that were finalized while they were controlling the network. This basically means that they are able to ‘double-spend’ coins. They wouldn’t be able to create any new coins or alter any old blocks. So, a 51% attack probably can’t destroy Bitcoin or another blockchain currency completely. This is still true, even if it turns out to be incredibly damaging.
To break down this attack, we must backtrack a little to go over the functions of blockchain technology. Bitcoin and many other cryptocurrencies base their systems on blockchains. These digital files record each and every transaction made on a cryptocurrency’s network and are available to all users for review. The general public has this privilege as well. All of this means that no one is able to spend a coin twice (i.e. double-spend).
Frankenfield provides a formal definition for the standard blockchain:
“As its name implies, a blockchain is a chain of blocks, bundles of data that record all completed transactions during a given period of time. For bitcoin, a new block is generated approximately every 10 minutes. Once a block is finalized – “mined,” in the jargon – it cannot be altered, since a fraudulent version of the public ledger would quickly be spotted and rejected by the network’s users.”
Difficulty for attackers
By commanding the bulk of the computing power on the network, an attacker or an attacker group can interfere with recording new blocks. They are also able to stop other miners from completing blocks. Therefore, they can dominate the mining of new blocks and earn all of the rewards. In addition, they can send a transaction and reverse it afterward. This makes it appear as though they still possess the coin that they had just spent.
Double-spending is the digital equivalent of the ideal counterfeit and the cryptographic hurdle that blockchain was made to overcome. In essence, a network allowing double-spending will suffer a loss of confidence at an alarming rate.
Altering historical blocks is an extremely difficult task, even in the event of a 51% attack. The further back the transactions are, the trickier it is to change them in any way. It is next to impossible to change transactions prior to a checkpoint, past the point of hard-coding transactions into Bitcoin’s software. Be that as it may, a type of 51% attack is actually possible. This comes from using less than 50% of the network’s mining power, however, it has a low probability of success.
Below is a list of platforms that were victims of 51% attacks:
- ghash.io: In July of 2019, the mining pool exceeded 50% of the Bitcoin network’s computing power for a brief period. The result was the pool vulnerability committing to a network share reduction. According to a statement, it won’t reach 40% of the total mining power at any point in the future.
- Krypton and Shift: These two blockchains – deriving from Ethereum – went through several 51% attacks in August of 2016.
- Bitcoin Gold: This cryptocurrency experienced a 51% attack in May of 2018. The attacker(s) took control of a great amount of its hash power. So, despite Bitcoin Gold trying to raise the exchange threshold, the attacker(s) was double-spending for days. The total amount that they stole was roughly $18 million.
PoS & 51%
Now, with a PoS, the attacker needs to obtain 51% of the cryptocurrency to conduct an attack. The PoS avoids this by making it difficult for a miner with a 51% stake to attack the network. The difficulty of compiling 51% of a reputable digital coin – not to mention the overall cost – is something important of note. However, a miner with a 51% stake won’t have it in their best interest to attack the network. Especially not a network that they hold a majority share of. If the cryptocurrency value falls, then the value of their holdings will also fall. Thus, the majority stake owner has the incentive to maintain a secure network.
Different levels of PoS
It’s quite common in PoS cryptocurrencies to allocate those possessing a bigger interest in the network with bigger benefits. This is both in network authority (like voting weight) and rewards. Because of this, cryptocurrency networks usually offer various levels of staking. In other words, the more coins you put aside for staking, the bigger the network will reward you.
This effectively leads in two distinct types of staking: masternode staking and non-mode staking.
Masternodes are network participants that validate and authenticate transactions on a PoS blockchain. To apply for one, participants have to abide by several minimum requirements. This will often vary depending on the network, but it may include locking a set number of tokens away. This will typically be a pretty large minimum. Moreover, it includes being a participant holding tokens for a period of time and being a reliable community member.
The distribution of rewards is part of the network fees (i.e. transaction fees) and are prone to being big. This is because the network’s vested interest has to be big. Not only that, but the entry barrier is also pretty high, so you need a large initial investment to become a masternode.
Let’s use a scenario about becoming a Neo masternode as an example. These masternodes also go by the name of ‘bookkeepers’ or ‘consensus nodes.’ A participant has to stake a total of 1,000 gas (which equates to $2,150) to nominate themselves in the role of bookkeeper. Furthermore, this is to acquire a consensus authority certificate before Neo community members are even able to vote. The Neo mainnet has a limit of seven consensus nodes.
Likewise, to apply for masternode status (‘Authority Masternode’) on VeChain (VET), a participant needs to stake 25 million VET. This amount equates to $97,500. In addition, they will have to complete a Know Your Client (KYC) authentication in the VeChain portal. The masternode positions have a member limit of 101.
Masternodes of VeChain receive compensation in part by transaction fees, as well as a portion of a foundation reward pool.
Non-node staking isn’t as difficult, and there’s no involvement of users pertaining to transaction validation. There is no minimum amount of staking; in fact, there’s usually no minimum holding period. This essentially means that the entry barrier is considerably lower.
So, all a network participant has to do is hold the cryptocurrency in the network’s wallet. Once they do this, they can begin to earn either interest or dividend payouts.
Below is a list of other PoS cryptocurrencies suitable for staking:
- Ontology (ONT)
- Pivx (PIVX)
- Factom (FCT)
- Tezos (XTZ)
- Cardano (ADA)
- Decred (DCR)
- EOS (EOS)
- Dash (DASH)
- Waves (WAVES)
- Livepeer (LPT)
If you go by what’s said on POS List and masternodes.online, the rewards and earnings for both types of staking vary significantly between cryptocurrencies. This means that it can be anything from 0.7% to over 1,000%.
The likelihood of long-term gains has led to the commencement of a number of startups. These startups focus primarily on providing staking services to a variety of investors. These include Anchorage, Eon Staking Inc., Figment and Staked.
If anyone has any remaining doubt about strong market interest in cryptocurrency staking, Staked may end up changing that belief. They made an announcement saying that they raised $4.5 million in seed investment from institutional investors. Some of these investors include Pantera Capital, Coinbase Ventures and Winklevoss Capital. Anchorage initiated in January of 2019 – following a $17 million funding round – and was led by Andreessen Horowitz.
Veradittakit states that:
“Pantera invests in many leading proof-of-stake projects, so we knew we needed a staking solution. […] We liked Staked because of the experienced team, focus on institutions, and broader vision around helping investors earn yield on their cryptocurrency.”
It should come as a surprise to no one that PoS staking is not without some risks. This system is not solely a bear market game; on the contrary, it’s a long game. With that in mind, a momentous level of trust needs to be put in the cryptocurrency network. That trust has to go into the belief that it will make it through the bear market. Not only that but that it will still be operational on the other side. Finally, they have to trust that they will regularly payout both earnings and rewards in the long run.
An additional risk is the monopolization of a network. This is where a collection of large token holders end up obtaining the lion’s share of the rewards. Alongside the risk of monopolization is the possibility of a 51% attack. Even though it is much more costly – not to mention counterintuitive – the orchestration of an attack is still possible. Moreover, the likelihood of devaluing the network is relatively high.
In spite of the risks, coin staking has already proven to be a noteworthy concept concerning validation and long-run success. The act of staking coins provides currency holders with decision power on the network. By utilizing staking, you effectively acquire the ability to generate a substantial income.
What staking has over regular trading is the number of gains you can garner from it. In this sense, it’s no wonder that so many people are flocking to this tactic. Be that as it may, it is wise to at least remind yourself that for every gain, there’s a probability of risk.